Inventory Valuation

7
CHAPTER

Merchandising Mathematics for

Retailing, 5e
Cynthia R. Easterling
Beth E.S. Wuest
MERCHANDISING
MATHEMATICS FOR RETAILING
FIFTH EDITION

c7 Inventory Valuation

Cynthia R. Easterling | Beth E.S. Wuest

c7 OBJECTIVES

 To define and determine retail deductions.

 To explain the differences among book
inventory, physical inventory and estimated
physical inventory.
 To define and calculate shortage based on
book and physical inventory figures.
 To understand why department and specialty
stores use the retail method of inventory (RIM)
 To calculate maintained markup and gross
margin using the retail method of inventory.
 To calculate gross margin return on inventory.

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CHAPTER 7 SUMMARY

Calculation of Book Inventory

Calculation of Shortage

Estimated Shortage

Methods of Inventory Valuation

Gross Margin Return on Investment

Review of Cumulative and Maintained Markup

c7 TYPES OF INVENTORY

Physical Inventory
•Actual count of goods in units and dollars

Perpetual Inventory
•Also known as book inventory
•Based on accounting books or records
•It gives the buyer the total retail value of stock at
anytime

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c7 CALCULATION FOR BOOK INVENTORY

Book Inventory
= Total Merchandise Handled – Retail Deductions

When utilizing a perpetual inventory it is important

that extensive records be maintained because
everything that affects the value of the inventory
must be reported.

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c7 CALCULATION OF BOOK INVENTORY
Transactions that increase the value of the inventory
include
• Purchases
• Transfers in
• Customer returns
• Markdown cancellations
• Additional markup

Transactions that reduce the value of inventory

include
• Return to vendors
• Markdowns
• Revisions downward
• Transfers out
• Employee discounts

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c7 Total Merchandise Handled

CALCULATING TOTAL MERCHANDISE

HANDLED

Total Merchandise Handled

= Beginning Inventory + Net Purchases + Net
Transfers + Net Price Revisions

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c7 Total Merchandise Handled

Beginning Inventory
•When available use physical inventory because it is
more accurate than a book inventory figure
Net Purchases
•Returns to vendors (RTVs) are subtracted from
gross purchases
Net Transfers
•Merchandise is frequently transferred between
stores and may be transferred between
departments. A transfer in is treated like a purchase;
a transfer out is treated like an RTV

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c7 example 7-1

Determine the value of total merchandise handled from the

following figures:

Opening inventory $20,000

Gross purchases $10,000
RTV $450
Transfers out $350
Transfers in $150
Additional markup $48
Additional markup cancellation $16

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c7 example 7-1 (continued)

Solution

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c7 Retail Deductions

CALCULATING RETAIL DEDUCTIONS

Retail Deductions
= Net Sales + Net Markdowns + Discounts to
Employees (and any other special customers)

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c7 Retail Deductions

Net Sales
•Customer returns and allowances are subtracted
from gross sales
Net Markdowns
•Markdown cancellations are subtracted from
markdowns
Discounts to Employees (and any other special
customers)
•These discounts reduce the amount of sales that
can be achieved from an inventory; thus, they must
be treated as deductions from total merchandise
handled
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c7 example 7-2

Calculate the total deductions and the closing book inventory

from the following figures:

Total merchandise handled $29,398

Gross sales $9,870
Customer returns $642
Employee discounts $380
Markdowns $936
Markdown cancellations $76

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c7 example 7-2 (continued)

Solution

Total merchandise handled $29,398

Gross sales $9,870
Customer returns $642
Net sales $9,228
Markdowns $936
Cancellations $76
Net markdowns $860
Employee Discounts $380
Total deductions $10,468
CLOSING BOOK INVENTORY $18,930

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c7 CALCULATION OF SHORTAGE

When the retailer takes a physical inventory, the

actual value of the inventory, as determined by the
physical count is compared with the book inventory
and adjusts the books so that they agree with the
physical inventory.

Shortage or Shrinkage
•Occurs when book inventory is larger than physical
inventory

Overage
•Occurs when physical inventory exceeds book
inventory
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c7 CALCULATION OF SHORTAGE

Shortage Percent
= Amount of Shortage / Net Sales

Causes of shortages include

• Theft – external and internal
• Breakage
• Incorrect measuring and weighing
• Giving samples
• Improper handling of sales transactions
• Incorrect counting of merchandise
• Failure to record merchandise on loan

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c7 example 7-3

During the spring season (February 1 through July 31), the

lingerie department had net sales of $350,000. On July 31, a
physical inventory showed $87,110 worth of merchandise. The
book inventory showed $92,610. What was the shortage
percent for the season?

Solution
Shortage
= Book Inventory – Physical Inventory
= $92,610 - $87,110
= $5,500
Shortage Percent
= Shortage Amount / Net Sales
= $5,000 / $350,000
= 1.57%
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c7 ESTIMATED SHORTAGE

CALCULATING ESTIMATED SHORTAGE

Estimated Shortage
= Net Sales x Estimated Shortage Percent

Estimated Physical Inventory

= Closing Book Inventory – Estimated Shortage

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c7 ESTIMATED SHORTAGE

Estimated shortage is the amount of shortage that

has probably occurred based on past experience.

Estimated physical inventory is the value of

inventory as determined from records after adjusting
for estimated shortage.

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c7 example 7-5

Calculate (a) Estimated shortage and (b) Estimated physical

inventory, using the following information:

Opening inventory $16,400

Net purchases $84,300
Net sales $76,000
Net markdowns $3,600
Employee discounts $2,200
Estimated shortage 1.60%

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c7 example 7-5

Calculate (a) Estimated shortage and (b) Estimated physical

inventory, using the following information:

Opening inventory $16,400

Net purchases $84,300
Total merchandise handled $100,700
Net sales $76,000
Net markdowns $3,600
Employee discounts $2,200
Total deductions $81,800
CLOSING BOOK INVENTORY $18,900
Estimated shortage ($76,000 X 1.6%) $1,216
Estimated physical inventory $17,684

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c7 ESTIMATED SHORTAGE

Book Inventory
•The value of the inventory as determined from
records rather than a physical count
Physical Inventory
•The value of the inventory as shown by an actual
count of the merchandise

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c7 ESTIMATED SHORTAGE

Estimated Shortage
•The amount of shortage that probably has occurred
on the basis of past experience
Estimated Physical Inventory
•The value of the inventory as determined by book
inventory after an adjustment has been made for
estimated shortage

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c7 METHODS OF INVENTORY VALUATION

Sales are made and reported in retail values; yet,

the calculation of profit and loss requires knowing
the cost value of opening and closing inventories so
that the cost of merchandise sold can be calculated.
Methods include
• Retail Method
• Original-Cost Method

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c7 Retail Method of Inventory Valuation

 A procedure whereby the approximate cost value

is determined from the retail value
 Used by most moderate and large-sized retail
firms
 Allows for the depreciated value of markdown
goods to be reflected in cost value of the
inventory

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c7 Retail Method of Inventory Valuation

Steps in Calculating Inventory Valuation

1. Calculation of total value of merchandise handled at
both retail and cost

2. Calculation of cost percent of total merchandise

handled (Cumulative markup can be calculated.)
Cost %
= Cost of Total Merchandise Handled
Retail of Total Merchandise Handled

3. Calculation of closing book inventory at retail

Closing book inventory
= Total Merchandise Handled
Total Retail Deductions

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c7 Retail Method of Inventory Valuation

Steps in Calculating Inventory Valuation (continued)

4. Calculation of approximate cost value of closing book
inventory
Cost of Closing Book Inventory
= Retail Value of Closing Book inventory x Cost %

The preceding steps give the complete inventory valuation at cost;

however, two more steps are necessary for the determination of
gross margin.

5. Calculation of gross cost of merchandise sold (Maintained

markup can now be calculated.)
Gross Cost of Merchandise Sold
= Cost of Merchandise Handled – Cost of Ending Inventory

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c7 Retail Method of Inventory Valuation

Steps in Calculating Inventory Valuation (continued)

6. Calculation of total cost of merchandise sold
Net Cost of Merchandise Sold
= Gross Cost of Merchandise Sold – Cash Discounts

Total Cost of Merchandise Sold

= Net Cost of Merchandise Sold + Alteration Cost

7. Calculation of gross margin $ and gross margin %

Gross Margin $
= Net Sales – Total Cost of Gross Margin

Gross Margin %
= Gross Margin $ / Net Sales

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c7 example 7-7

Calculate gross margin % given:

Cost ($) Retail ($) Cost ($) Retail ($)

Opening inventory 140,960 287,640 Additional markup xx 230
Gross purchases 47,520 98,300 Gross sales xx 112,430
RTV 1,010 2,180 Customer returns xx 11,020
Freight 810 xx Markdowns xx 14,210
Cash discounts 696 Markdown cancellations xx 1,980
Alteration costs 450 Employee discounts xx 830
Estimated shortage 0.95%*

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c7 example 7-7 (continued)

    -------------- Cost -------------     -------------- Retail -------------

Merchandise handled                
Opening inventory     $140,960         $287,640  
Gross purchases   $47,520         $98,300    
Returns to vendors   1,010         2,180    
Net purchases     46,510         96,120  
Freight       810         xx  
Additional markup     xx         230  
Total merchandise handled     $188,280         $383,990
Cost % of total merchandise handled                
Cost % = $188,280 ÷ $383,990 =   49.0325%            
                     
Deductions                  
Gross sales             $112, 430  
Customer returns             11,020  
Net sales               $ 101,410
Markdowns             14,210  
Markdown cancellations           1,980  
Net markdowns               12,230
Employee discounts               830  
Total deductions                 $114,470

Closing book inventory (retail) = total merchandise handled - total deductions        

Closing book inventory = $383,990 - $114, 470 =             $269,520
Estimated Shortage = net sales x estimated shortage %            
$101,410 x .95% =                 963
Estimated physical inventory = closing book inventory - estimated shortage          
$269,520 - $963 =                 $268,557
Closing estimated physical inventory (cost) = estimated physical inventory x cost %        
$268,557 x 49.0325% =     131,680          
Gross cost of merchandise sold     $56,600          
Cash discounts (minus)     696         
Net cost of merchandise sold     $55,904          
Alteration/workroom costs (plus)     450         
Total cost of merchandise sold     $56,354          
                     
Gross Margin $ = net sales - total cost of merchandise sold            
Gross margin $ = 101,410 - $56,354 =     $45,056          
Gross Margin % = gross margin $ ÷ net sales              
Gross margin % = $45,056 ÷ $101,410 =   44.43%            
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c7 Original-Cost Method of Inventory Valuation

 Used by stores with slow turnover or small

inventory in comparison to sales volume
 Based on maintenance of book inventory at cost
 An alternative method of maintaining book
inventory at cost is to refer to the vendor’s invoice
for cost information as items are sold
 This method is appropriate only when the number
of transactions is limited and items have a high
unit value

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c7 Advantages and Disadvantages of (RIM)

 Advantages
o Allows for more efficient merchandise management
o Is more accurate
o May be less expensive
o Is more flexible

 Disadvantages
o Extensive record keeping
o Complex and time-consuming
o May result in a cost value that is not an exact figure

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c7 Suggestions for Working RIM Problems

 Before starting to work a problem, determine in

which part of the problem each factor will be used.
 RIM problems can also be done on paper, in any
computer laboratory, or on a home computer.
 Utilizing a computer spreadsheet makes it easy to
do “what if” problems.

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c7 GROSS MARGIN RETURN ON
INVENTORY (GMROI)

GMROI is a ratio measuring efficiency of the

investment in inventory.
It is calculated by dividing the dollar gross margin by
average inventory at cost.
Average inventory at cost is calculated by adding the
beginning-of-the-month (BOM) cost inventory for
each month in the period plus the end-of-the-month
(EOM) cost inventory for the last month in the period
and dividing by 7 for a season or 13 for a year.

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c7 GROSS MARGIN RETURN ON
INVENTORY (GMROI)

CALCULATING GMROI

GMROI
= Gross Margin $ / Average Inventory at Cost

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c7 example 7-10

Calculate GMROI for a six-month season from the following

data:

Gross margin $365,945

Inventory at Cost:
BOM stock August $75,400
BOM stock September $80,200
BOM stock October $82,000
BOM stock November $95,000
BOM stock December $92,000
BOM stock January $72,000
EOM stock January $68,000

c7 page 37
c7 example 7-10 (continued)

Solution
Step 1: Find the average cost of inventory:

= $75,400 + $80,200 + $82,000 + $95,000 + $92,000 + $72,000 + $68,000

7
= $564,600 / 7
= $80,657

Step 2: Divide gross margin by the average cost of inventory:

GMROI
= Gross Margin $ / Average Inventory at Cost
= $365,945 / $80,657
= 4.54

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c7 REVIEW OF CUMULATIVE AND
MAINTAINED MARKUP

As discussed in Chapter 5, cumulative markup is

based on total merchandise handled and maintained
markup is based on gross cost of merchandise sold.
Cumulative Markup $
= Retail of Total Merchandise Handled – Cost of Total
Merchandise Handled
= $140,450 - $73,668
= $66,782
Cumulative Markup %
= Cumulative Markup $ / Retail of Total Merchandise
Handled
= $66,782 / $140,450
= 47.55%

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c7 REVIEW OF CUMULATIVE AND
MAINTAINED MARKUP

Maintained markup is calculated using gross cost of

merchandise sold

Maintained Markup $
= Net Sales – Gross Cost of Merchandise Sold
= $73,840 - $42,695
= $31,145
Maintained Markup %
= Maintained Markup $ / Net Sales
= $31,145 / $73,840
= 42.18%

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